Tuesday 27th September 2011

You would imagine that when a column in a newspaper begins with “I might be an economic dunce, but…”, it would serve as a pretty damn good signal to basically ignore much of what follows. Alas, no.

If you’re on Twitter then you may have seen this article by Charlie Brooker being retweeted today, as seems to happen most Mondays. Brooker’s articles are generally fairly popular amongst the Twitterati, and so they should be as they’re usually quite amusing. But with the latest one, I really couldn’t get past the pretty fundamental error.

The title of the article is “If capitalism has failed, how the hell do we pay for our Shreddies?“. And so we can see the issue. It’s a pretty basic error, but sadly it’s one which is commonly repeated in the present climate: the current economic crisis isn’t really a failure of capitalism – in many respects, quite the opposite. So it’s perhaps a little foolish to be pondering its death.

Fundamentally, the credit crunch which precipitated the present economic mess, happened for a number of reasons. Banks lent money to people to buy houses, which caused house prices to rise. Sadly, lots of money was lent to people who couldn’t afford really afford the loan (and it’s very easy to blame greedy bankers for this; no-one seems willing to blame the greedy consumers who took on debt they couldn’t afford. I suppose it’s politically more convenient to blame bankers though). So when those debts went bad, the banks repossessed the property and put them up for sale, to try to recoup their money. This influx of property into the market drove house prices down. Mortgages are loans secured against the value of a property, and so we reached the situation where there were lots of loans which were secured against property which was worth less than the value of the loan (i.e. if the bank sold the house, they wouldn’t get back all of the money they lent in the first place). Calamity ensued*.

Reading the preceding paragraph there are two blatantly obvious questions: why did the banks feel able to lend the money in the first place, and why did lots of people suddenly become unable to afford their debts? The answer is that central banks and governments set interest rates according to whatever agenda they have at the time. In the early 2000s interest rates were set low in an attempt to soften the effects of the dot-com crash and the terrorist attacks in America in 2001. This had the effect of reducing the cost of lending money, which meant that loans became affordable to more people. Because of the low interest rates, banks could now give mortgages to people who previously couldn’t afford them. And correspondingly, consumers presumably felt encouraged to take on this debt because they assumed that they’d always be able to find affordable finance, even if their initial loan became too expensive. After all, house prices were always going up…

Of course, the low interest rates weren’t sustainable, and when they rose in the latter part of the 2000s, the cost of debt rose accordingly. And then the people who could barely afford their loans when the rates were low, suddenly couldn’t afford the debt at a higher interest rate, and had no way to refinance their debt. And so they defaulted.

We can see then that one of the key weaknesses was nothing at all to do with capitalism, or the free-market liberalism which is often assumed to go with it. It was a housing bubble fuelled by low interest rates. A colossal failure of interventionist policy, and a reminder that centrally managing a fundamental part of the economy is not necessarily a wise thing to do. And this lesson is something that those people who are generally in favour of capitalism go to great pains to point out.

Which isn’t to say that there weren’t market failures as well; the existence of banks that were too big to fail, for instance. But without the interventionist policy – the setting of interest rates – it’s highly questionable whether the conditions would’ve existed for the rest of the crisis to follow, or for it to be as profound as it was/is. Far from the death of capitalism, this – along with the troubles we’re now seeing caused by excesses of sovereign debt – should really signal the end (or at least a reduction) of the interventionist state. Probably won’t be though, and we’re all the poorer for it.

Literally.

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* I’m afraid I’m simplifying a little here; there are other factors, such as the way that risk was dispersed throughout the financial system, and the rationale behind subprime lending. That’s somewhat beyond the scope of the point I’m trying to make though.

4 Comments:

Tuesday 27th September 2011, 9:25 am

However you could argue that it was the *lack* of an interventionist policy dictating conditions on which banks could lend to people that had the same effect. Without any setting of interest rates the situation of the early 2000s could have just become more extreme to an untenable level, and there will always be people who don’t understand the level of debt that they’re taking on – and it’s not in the banks’ capitalist interests to discourage such people from taking loans. Just sayin’…

Tuesday 27th September 2011, 11:21 am

Why should there be a policy dictating who a bank (or, indeed, anyone else) can do business with? The point I was making is that without setting interest rates the conditions would not have existed for the rest of the crisis to follow; I’m not sure how the situation could’ve become more extreme without that.

You’re suggesting that there should’ve been interventionist policy to correct the effects of interventionist policy. I suggest we should just do away with interventions.

Tuesday 27th September 2011, 1:35 pm

I’ve just reread that section of your post and you do say “Of course, the low interest rates weren’t sustainable”. Fair enough, agreed. I think what I’m saying is that there’s a place for a different *type* of interventionist policy – protecting the consumer’s interests in the face of wider market forces, which will always exist in some guise or another no matter what the exact nature of that market.

FWIW, I do agree that the consumer has to take responsibility as well, but again, I see this as pointing to the need for better fiscal education and better example-leading from the top downwards, not just relying on personal choice to win out.

Offering up myself as an example, I am economically-savvy enough to know that unpayable debts are a Bad Thing and enough to hold a position in an argument such as this, but when all’s said and done, I don’t really have a grip on how or why these sorts of things work. And if I’m literate and (incredibly) numerate and I’m saying that, then what sort of a chance does half of the country have?

It seems to me that the whole principle of gambling on thin air is what’s really led us into trouble, and to me, that is what capitalism represents more than any reward-based-on-effort scheme. Let’s go back to trading in goats.

Tuesday 27th September 2011, 2:08 pm

Yeah, what I was addressing in the post was really just direct intervention in the markets. I agree that government should intervene in other ways to protect consumer interests to prevent things which are exploitative (for instance, the recent case of mis-sold payment protection insurance).

And I fully agree about educating people about finance. I think it’s rather shocking how ill informed many people are about money, finance and the economy, and it’s probably quite damaging really.

As to the comment about “gambling on thin air”, I disagree. It’s interesting how much of this seemingly invisible activity is really rather beneficial, in making markets more efficient and more stable. And the rewards from this generally are for doing things which are useful, it’s just that the results aren’t necessarily obvious.

For instance, financial speculation moves prices in time, thus reducing the likelihood that low prices at one particular point in time will cause a resource to be consumed too quickly, causing a shortage. Speculation is something which is often held up as an example of an intangible, useless activity; yet it helps avert famines. That’s kinda useful.